2024 has been a year of extremes in the stock market. Can it last?

As for emerging markets, they might have boomed during the early 2000s, but the promise of economic convergence has turned out to be unfulfilled outside Asia. (Bloomberg)
As for emerging markets, they might have boomed during the early 2000s, but the promise of economic convergence has turned out to be unfulfilled outside Asia. (Bloomberg)

Summary

As extended as some trends have become this year, investors shouldn’t assume that they are about to revert to the mean.

Stocks: They don’t make them like they used to.

In 2024, extreme market trends have become even more so. U.S. equities, which had already more than doubled the performance of international ones between 2000 and 2023, have delivered a further 29% return, compared with less than 9% for non-U.S. stocks, based on MSCI indexes.

This is because of further U.S. dollar appreciation and because the technology-related Magnificent Seven—Apple, Microsoft, Amazon.com, Alphabet, Meta Platforms, Tesla and Nvidia—have grown to make up about a third of the S&P 500, compared with roughly a quarter at the end of 2023.

The megacap rally has been so brutal that the S&P SmallCap 600 has lagged behind despite receiving a bump from the Trump trade. Fateful past periods of small-caps’ having relative price/earnings ratios as low as today include the Nifty Fifty era of the 1970s and the dot-com bubble of the late 1990s. In the aftermath of these episodes, small-caps went on to outperform blue chips significantly.

The Stoxx Europe 600 looks cheap too, and not just because it has little tech. U.S. stocks are pricier in every single sector. Unilever has a forward P/E ratio of 18, compared with Procter & Gamble’s 24, for example, and Exxon Mobil scores 14, to Shell’s eight.

Also, the dollar hasn’t been as consistently strong in inflation-adjusted terms since the 1980s, which then became the start of a decadeslong depreciation.

So, if past patterns reassert themselves, long-term investors must only avoid the crowded trades, buy the discounted stocks and sit pretty. But this is a big “if."

“Historical trends are being permanently broken in real time as mega forces, like the rise of artificial intelligence, transform economies," said BlackRock in its recent outlook for 2025.

The world’s top investment manager by assets recommends that investors stick with U.S. stocks, embrace actively managed funds and delve into private markets. This conveniently aligns with BlackRock’s own commercial strategy—it recently announced the purchase of the private-credit firm HPS Investment Partners—but correctly highlights that valuations don’t exist in a vacuum.

After the 2008-09 financial crisis, the gross domestic product of most Western countries stuck to a lower trajectory even as growth recovered. This shattered preconceptions about economies’ being mean-reverting, and popularized the study of “hysteresis," or how short-term shocks can have long-lasting effects.

Then came the pandemic, when the U.S. course-corrected by mailing cash to households and increasing unemployment benefits. It also benefited from having fostered tech giants that rode the dual waves of a more-digital economy during Covid and the rise of generative AI thereafter. It worked: U.S. gross domestic product is already above where the pre-Covid trend suggested it would be.

Meanwhile, the more austere, “old economy" eurozone appears to have suffered another enduring hit. Positive economic surprises in early 2024 have been offset by a disappointing past few months.

Throughout the postpandemic period, the European Central Bank has taken cues from the Federal Reserve and set interest rates aggressively high, disregarding that it was dealing with a weaker economy.

The European Union’s export-led model is more challenged than ever by Chinese overcapacity and the threat of U.S. tariffs. Ongoing political crises in Germany and France make it even harder for the bloc to establish a coherent industrial policy, despite an action plan from former ECB President Mario Draghi.

As for emerging markets, they might have boomed during the early 2000s, but the promise of economic convergence has turned out to be unfulfilled outside Asia. Since the 2008-09 financial crisis, these nations have learned to protect themselves better against financial shocks, but this has meant allowing local currencies to depreciate more and building up dollar coffers. To boot, the shale revolution has turned the U.S. into a net energy exporter.

These are all sources of strength for the dollar. As much as Donald Trump might prefer a cheaper exchange rate, the experience of the 1980s suggests that it would take a coordinated international effort to achieve it.

Or take U.S. small-caps. Their return on assets was only slightly below the S&P 500’s two decades ago. Now it is at a third, both because megacaps have become more profitable and because there are fewer high-quality small companies traded on exchanges.

Between the 1996 peak and 2022, the number of listed U.S. companies fell 43%, even as it kept growing abroad, World Bank WDI figures show. Overall, this is because cash-rich megacorporations are buying more companies, research finds. But the doubling in size of private markets over the past 10 years is also helping the best small businesses stay private for longer. The average company listing on the Nasdaq has become larger and older.

It only takes a few superstars to bypass the small-cap universe to justify a lower valuation for all. Kenneth French and Eugene Fama identified that the past outperformance of these stocks has come from a few companies that graduate to a larger category.

To be sure, huge divergences in things such as P/E ratios could be signaling some froth in markets. But investors betting on a simple reversion to the mean might be disappointed. This isn’t your grandfather’s stock market.

Write to Jon Sindreu at jon.sindreu@wsj.com

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